Why Would A Lender Choose A Workout or Modification?
Mortgage foreclosures can be expensive and protracted legal proceedings. Foreclosure in many states involves prolonged litigation, with the attendant expense of attorneys' fees and costs. During the time litigation is pending, unpaid interest is accruing on the loan and the real property taxes may fall delinquent. In addition, the borrower can file a petition for bankruptcy even after the foreclosure process has been pending for some time, causing further delays. Some states require transfer taxes once be paid by a lender once the property is acquired through foreclosure. In many situations, the time and expense of a mortgage foreclosure does not make sense if there is a way to reach an agreement with the borrower short of litigation.
Another factor weighing in against foreclosure proceedings is that most lenders are not in the business of owning and managing real estate. Loan officers are not trained in property management. During the mortgage foreclosure, if the property appears to be at risk in any way, the lender might request the court to give control of the property to the lender as “mortgagee-in-possession”, wherein the lender takes over the management of the property while the foreclosure case is pending. Therefore, there may be the additional expense of hiring a property management company during mortgage foreclosure proceedings.
Most lenders are not equipped to manage the day-to-day operations of a commercial property. Depending on the real estate market at the time of the foreclosure, it could take some time to sell the property after the mortgage foreclosure case had been completed. During that time, the lender is exposed to liability associated with property ownership, such as tort claims and environmental issues. The expense and liability for general maintenance and repair of the property falls on the shoulders of a lender who becomes the owner of real property through a foreclosure.
There may be other reasons to enter into a loan modification with the borrower rather than begin immediate foreclosure. The lender may obtain certain concessions from the borrower in return for not foreclosing. The lender might request additional interest if the borrower's cash flow improves. The borrower might pledge stock or other equity interest in the property to the lender in exchange for forbearance or of modification of terms. If the cash flow problem appears to be temporary, for example, a vacancy caused by a large tenant departure, but there is a reasonable likelihood of finding another tenant, the lender might want to work with a borrower to get past a short term issue and not foreclose.
There also might be accounting reasons to modify the loan. Most lenders are highly regulated and still must report or “right down” a bad loan. If the lender has a non-performing loan, it may be required to write off the loan as an asset of the lender, regardless of whether the loan is in foreclosure. But by a workout or loan modification, the lender may not be forced to write down the loan on its books.
Another factor weighing in against foreclosure proceedings is that most lenders are not in the business of owning and managing real estate. Loan officers are not trained in property management. During the mortgage foreclosure, if the property appears to be at risk in any way, the lender might request the court to give control of the property to the lender as “mortgagee-in-possession”, wherein the lender takes over the management of the property while the foreclosure case is pending. Therefore, there may be the additional expense of hiring a property management company during mortgage foreclosure proceedings.
Most lenders are not equipped to manage the day-to-day operations of a commercial property. Depending on the real estate market at the time of the foreclosure, it could take some time to sell the property after the mortgage foreclosure case had been completed. During that time, the lender is exposed to liability associated with property ownership, such as tort claims and environmental issues. The expense and liability for general maintenance and repair of the property falls on the shoulders of a lender who becomes the owner of real property through a foreclosure.
There may be other reasons to enter into a loan modification with the borrower rather than begin immediate foreclosure. The lender may obtain certain concessions from the borrower in return for not foreclosing. The lender might request additional interest if the borrower's cash flow improves. The borrower might pledge stock or other equity interest in the property to the lender in exchange for forbearance or of modification of terms. If the cash flow problem appears to be temporary, for example, a vacancy caused by a large tenant departure, but there is a reasonable likelihood of finding another tenant, the lender might want to work with a borrower to get past a short term issue and not foreclose.
There also might be accounting reasons to modify the loan. Most lenders are highly regulated and still must report or “right down” a bad loan. If the lender has a non-performing loan, it may be required to write off the loan as an asset of the lender, regardless of whether the loan is in foreclosure. But by a workout or loan modification, the lender may not be forced to write down the loan on its books.